Domestic resource mobilization is becoming increasingly important in many developing countries because of the problems they are facing in attaining additional foreign resources and aid. But in many countries systematic disincentives must be removed before the full rural deposit mobilization potential can be realized. This paper presents an analysis of rural deposit mobilization in four Asian countries: Bangladesh, Indonesia, the Philippines and Thailand. With the exception of Bangladesh, there is no clear upward trend in share of rural deposits relative to total deposits. Institutions specializing in rural lending appear to mobilize an even smaller share of their total resources than the rest of the banking system. Determinants of savings behavior are discussed considering incentives for both savers and lenders. Administered interest rates are identified as a problem because they often result in negative real rates on deposits for savers while making rediscount and other government funds cheaper for banks/branches than mobilizing deposits. Efforts to expand banks/branches into rural areas have been thwarted by credit policies which make them unviable. Therefore, reforms in interest rates and other financial policies are often a necessary first step in expanding rural deposit mobilization

Esguerra, Emmanuel F.

Meyer, Richard L.

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Economics and Sociology Occasional Paper No. 1198 RURAL DEPOSIT MOBILIZATION IN ASIA Richard L. Meyer Emmanuel F. Esguerra August 1985 The Ohio State University Agricultural Finance Program 2120 Fyffe Road, Columbus, Ohio 43210 Paper presented at the XIX International Conference of Agricultural Economists, Malaga, Spain, August 26 - September 4, 1985 RURAL DEPOSIT MOBILIZATION IN ASIA by Richard L. Meyer Emmanuel F. Esguerra Abstract Domestic resource mobilization is becoming increasingly important in many developing countries because of the problems they are facing in attaining additional foreign resources and aid. But in many countries systematic disincentives must be removed before the full rural deposit mobilization potential can be realized. This paper presents an analysis of rural deposit mobilization in four Asian countries: Bangladesh, Indo-nesia, the Philippines and Thailand. With the exception of Bangladesh, there is no clear upward trend in share of rural deposits relative to total deposits. Institutions specializing in rural lending appear to mobilize an even smaller share of their total resources than the rest of the banking system. Determinants of savings behavior are discussed considering incentives for both savers and lenders. Administered interest rates are id~ntified as a problem because they often result in negative real rates on deposits for savers while making rediscount and other government funds cheaper for banks/branches than mobilizing deposits. Efforts to expand banks/branches into rural areas have been thwarted by credit policies which make them unviable. Therefore, reforms in interest rates and other financial poli-cies are often a necessary first step in expanding rural deposit mobili-zation. RURAL DEPOSIT MOBILIZATION IN ASIA INTRODUCTION Domestic resource mobilization is becoming increasingly important in many developing nations, in part because of problems they are facing in obtaining additional foreign resources. Commercial lenders are fright-ened by high levels of foreign indebtedness. Donor agencies are reluct-ant to provide additional large grants and loans because they are also concerned about indebtedness and their total real resources are no longer growing at a rapid rate. Concern is also mounting over the past inef-ficient use of aid. Many financial institutions that have received large amounts of aid have failed to attain expected levels of institutional efficiency and viability. Thus many countries are stressing resource mobilization strategies to help fund agricultural sectors that have been buffeted in recent years by weak commodity demand and volatile prices. Although the need for domestic resource mobilization is widely recognized, there is less consensus about the ability to mobilize rural funds. Many policymakers are skeptical that deposit mobilization will succeed in rural areas because of low incomes, preferences for non-financial savings, and unfamiliarity with formal intermediaries. This paper discusses rural deposit mobilization in selected Asian countries. Some Asian countries have done exceptionally well (especially Taiwan and South Korea), but the central argument of this paper is that the countries studied (Bangladesh, Indonesia, the Philippines and Thai-land) have not stressed rural deposits because of cheaper funds avail-able from donors and governments. Systematic disincentives must be re-moved before the full potential for rural deposit mobilization can be realized. DEPOSIT MOBILIZATION AS A SOURCE OF LOANABLE FUNDS Although there hav~ been significant year-to-year variations, the banking systems in these four countries reported private deposits repre-senting 50-75 percent of total liabilities between 1970 and 1982 (Meyer and Esguerra). There appears to have been a downward trend in Bangladesh and the Philippines since 1978, and sine~ 1980 in Indonesia. In Thailand the share of deposits fell from 1970 to 1978, then rose to their highest level of 79 percent in 1982. Table 1 reports rural deposits as a percent-age of total deposits.l/ Bangladesh showed a fairly consistent upward trend in rural deposits from under 10 percent of total deposits in 1976 to over 15 percent in 1982. In the other three countries, rural deposits have fluctuated widely between 22 and 34 percent with no clear trends. These data can be interpreted in two ways. One interpretation is that deposits, and especially rural deposits, have not become signifi-cantly more important as a source of bank liabilities. A second inter-pretation is that rural deposits have done well by keeping up with growth in total deposits so the rural deposit share is roughly unchanged. While private deposits and rural deposits have not been an exceptionally dynam-ic source of bank liabilities, their growth has not been a drag on re-source mobilization through financial systems in these countries. - 2 -Another way to analyze rural deposit trends is through the perform-ance of specialized rural financial institutions. Such institutions should have advantages in rural deposit mobilization because of their objectives, thejr location in rural areas and their operational policies and procedures. Data were analyzed for the Bangladesh Krishi Bank (BKB), the Philippine rural banking system, and the Thailand Bank for Agricul-ture and Agricultural Cooperatives (BAAC). These institutions are impor-tant sources of formal agricultural credit. Table 2 reports their sour-ces of funds for 1978 to 1982. Deposits are overshadowed by other sour-ces of funds; governments, through central banks, provide the largest single source of funds. BKB increased deposits so the deposit share rose from approximately 23 percent to about 29 percent, while rural banks in the Philippines maintained a deposit share of about 32 percent. BAAC deposits represented about 16 percent of total funds in 1978, fell to 12 percent by 1980, and recovered to 15 percent in 1982. BAAC benefits from Central Bank credit and regulations requiring commercial banks to de-posit funds with BAAC if they do not meet agricultural lending targets. These two sources represent 50 to 60 percent of total BAAC funds. These three important rural credit sources clearly are not self-financed by deposits. In fact, they mobilize a smaller share of resources than the rest of their respective banking systems. Governments played an important role in creating them and continue to support them with funds. The sources of deposits are not reported, but it is likely that they come from rural and urban sources. DETERMINANTS OF SAVINGS BEHAVIOR Successful rural deposit mobilization strategies require an under-standing of the determinants of household savings. Although individual studies have arrived at mixed conclusions, a consensus of opinion now seems to be emerging. Incentives for both savers and financial insti-tutions need to be considered. Interest Rates A fundamental question concerns the influence exerted by interest rates on savings. The alternative possibilities are summarized by Lanyi and Saracoglu (page 6): "While an increase in interest rate may stimu-late savings by making future consumption less expensive relative to current consumption (substitution effect), it may also tend to reduce saving by lowering the amount of present saving necessary to buy a given amount of future consumption (income effect)." Their analysis, largely based on Asian and Latin American experience, suggests that the substitu-tion effect is most important in developing countries, although not over-whelmingly so. Malaysia and Korea are identified as examples where a steady policy of positive inflation-adjusted interest rates has led to steady growth in financial intermediation. The form in which savings are held is more important for deposit mobilization than the amount of savings. In countries where interest rates have been depressed over long periods, where financial institutions and instruments are underdeveloped and fragmented, and where there is great economic and political uncertainty, savings are typically held in the form of real estate, consumer durables, precious metals and foreign currency. Rural savers logically concentrate their wealth in land, livestock, crop inventories and jewelry. When interest rate repression - 3 -is an important d~terminant in this pattern of savings, a substantial in-rr~ase in interest rates can be expectPd to inctease fjn~ncial savinns. Most Asian countri~s have pursued policies which retard growth ot the financial sector (Fry). Nominal interest rates are usually set by administrative fiat. All countries included in Fry's study (including [ndonesia, the Philippin~s. and Thailand) target cr~dit throuRh reilin~s and/or floors for credit flows to priority sPctors or harrowers, and differentiated interest rates for size, group, sector or location of borrower, or source of funds. Subsidized government funds are available for rediscounting loans made by commercial lenders or specialized insti-tutions to priority borrow~rs. These controls frequently lead to low rediscount rates for farm lending, and negative real rates for both agricultural loans and deposits. The interest rate problem is demonstrated in Table 3. Only the Philippines' structure of partially floating interest rates permits mar-ket forces to influence deposit rates. The other three countries administra-tively fix almost all lending, rediscount and deposit rates. Two key relationships are noted. First, the rates paid for some deposits are set at levels equal to, or even above, some agricultural loan rates. These rates, of course, underestimate effective intermediary costs because they exclude the effects of reserve requirements and administrative costs. lherefore, effective deposit costs are considerably higher than agrirul-tural loan rat~s.f/ Second, rediscount rates are frequently lower than rates paid on some types of savings and time deposits. The spread be-tween rediscount and agricultural lending rates is not always large, but is frequently larger than for loans from mobilized deposits. This interest rate structure shows that financial institutions, especially those required or encouraged to make agricultural loans, can-not afford to mobilize large amounts of private deposits. They must rely on rediscount funds and other subsidized funds which are often cheaper and more reliable. When lenders mobilize rural deposits, they frequent-ly channel them to urban areas where lending rates are higher. Savers are discouraged by low and negative real rates of return. Therefore, interest rate reform is often a necessary first step for increasing in-centives for both savers and financial institutions. Access to Banking Facilities Access to deposit-taking facilities is another important factor affecting rural deposit mobilization. All four countries have pursued policies to expand rural banks and/or branches. However, policies de-signed to push out credit have created problems in making them finan-cially viable. Beginning in 1976, nationalized commercial banks in Bang-ladesh were required to make agricultural loans and to establish two rural branches for each urban branch licensed. By 1982, two-thirds of the scheduled bank branches were located in rural areas compared to less than half in 1976 (Rana). This policy was suspended, however, because the expansion was not coordinated, resulting in a surplus of branches in some areas and a deficit in others. Furthermore, many rural branches are not viable because of the low interest rates for agricultural loans and because subsidized rediscount funds are available for only 50 percent of agricultural loans. The banks, therefore, are still basically urban-oriented and channel many rural deposits to urban areas. The Philippine Rural Bank Act of 1952 marked the beginning of a major effort to expand rural banking. The Government provided equity capital for rural banks, technical assistance in bank organization and operation, and training of officers. Other incentives were Central Bank - 4 -rediscounting at preferential rates and exemptions from a variety of taxes, charges and fees. Some rural banks accepted demand deposits, but now this function has been exclusively granted to commercial banks. The number of rural banks multiplied at a fast rate, reaching 931 banks with 1,029 offices by 1978 (Lee and Jao), but serious loan repayment problems have created great financial problems for many rural banks and slowed their e~pansion. The Bank of Thailand relaxed its control over opening new commercial bank branches in 1975. About three times as many branches were opened in 1976 as compared to the average number opened per year during the prev-ious four years. However, the rate of expansion slowed in 1977 because banks experienced difficulty in meeting credit targets requiring that at least 60 percent of local deposits must be lent locally and at least one-third of the loans had to go to farmers (Meyer, Baker and Onchan). 2ther Determinants of Deposits Besides interest rates and access to financial institutions, other less well-documented factors influence rural deposit mobilization. Sever-al countries have successfully used prizes, raffles, lotteries, and other devices to stimulate deposits. Prizes raise the effective rate of return, while raffles and lotteries offer the possibility of an exceptionally high return and appeal to the gaming spirit of savers. Complicated pro-cedures for making and withdrawing deposits lower effective rate of return. The value of time to make and withdraw deposits, costs of pass-books, photographs for identification cards, and other miscellaneous costs can significantly reduce real returns. Von Pischke argued that the most important advantage for rural people may be convenience, that rural deposits may be more ''service" than interest elastic. Although the potential for rural deposits is great, the unit cost for the financial institution per depositor or account may be large for small deposits made by rural people. Some costs and procedures identi-fied above are used to screen out small deposits. Innovations and stream-lined procedures are required to reduce costs and open up deposit possibil-ities for more savers. Some of the huge subsidies currently spent for agricultural loans should be directed towards experiments with savings innovations so solutions to these problems will be more quickly found. CONCLUSIONS The major rural financial institutions in Bangladesh, Indonesia, the Philippines and Thailand have not been very successful in mobilizing rural deposits. Fragmentary data suggest, however, that a large untapped potential exists. Institutions heavily engaged in agricultural lending often have few incentives to mobilize rural deposits. Rules, regulations and incentives are geared towards expanded lending. Administered inter-est rate structures combined with high reserve requirements are major disincentives for deposit mobilization. Rediscount and other government funds are cheaper than deposits. Interest rate reforms are required that increase the return to savers, raise the cost of refinance funds rela-tiv~ to deposits, and increase the lender's return from rural loans. Establishing floating rates in the Philippines and the recent increase in rP.discount and lending rates for agriculture in Bangladesh are steps in the riRht direction. The expansion in rural banking can be reinvigorated through proper incentives to savers and intermediaries. - 5 -Huge amounts of capital are going to be required in the future as developing countri~s continue to modernize agricultur~. The wide fluctu-ations in rural in<'omf's experiPnred :in many c·otmtries during thf' p.lst 1-P, V<'ars have mc~ant additional tinan1'ial riem.1nds to hc~lp Lu·ms PV£->n out (',tsh flow. foreign sources ot tunrls are likely to be more limited in the future than in the past. Therefor~, the deposit mobilization potential in rural areas must be tapped. The past one-sided emphasis on cheap agricultural loans with related disincentives for deposit mobilization must be reversed. The creation of viable financial institutions with active deposit mobilization activities should become a high priority. Notes 1/ Data on rural deposits are at best approximate indications of depos-its by rural households. Undoubtedly some urban households and bus-inesses have deposits in rural areas and some rural households have urban deposits. 2/ The average cost of funds to an intermediary is, of course, lower than these rates because come deposits earn low or zero rates of intf'rest. Table 1 Rural Deposits as a Percent of Total Deposits 1976-1983 Country Year Bangladesh Indonesia Philippines Thailand (Percent) 1976 9.7 25.8 NA 34.2 1978 13.6 23.5 31.9 31.9 1980 14.9 22.0 24.6 33.8 1982 15.6 27.4 30.7 34.1 --·-----~ -----~ -- -- --~--·--- ---Source: Year 1978 1979 1980 1981 1982 Papers by Mridha, Siswanto, TBAC and Bavovada. Table 2 Share of Deposits for Selected Institutions 1978-82 Philippines Rural BKB Banks (Percent) 23 32 25 32 25 31 28 32 29 32 BAAC 16 14 12 15 15 Sources: Asian Development Bank; TBAC; Bank of Thailand, Quarterly Bulletin, December, 1983. Table 3 Selected Loan, Rediscount and Deposit Rates Country Rate Banglades~/ Indonesia~/ Philippines£/ Thailan~/ (Nominal Interest Rates Per Annum) Lending Rates for Major Agricultural Preograms: Short-term credit Medium/Long term credit Deposit Rates: Demand Savings Time 12 months & over) 12 & 17.5 13 - 14 4.5 - 8.5 10 14 Rediscount Rates for Agriculture 6 9 - 13.5 floating 10.5 floating 3 - 9 floating 9, 12 - 15 floating 18 - 19 floating 3 - 4 floating 7 - 14 7 - 16 0.5 - 9 9 13 5 Source: Meyer, Richard L. and Emmanuel F. Esguerra, "Rural Deposit Mobilization in Selected Asian Countries", APRACA Workshop on Rural Savings Mobilization, October 3-5, 1984, Manila, Philippines. a/ All rates effective from October 1980 for all scheduled banks. Recent changes in loans and rediscount rates for agriculture not included. b/ Data as of 1984 except lending and rediscount rates are for 1982. ~/ Data as of March 9, 1984. d/ Data as of 1982. 0'\ -7-References Asian Development Bank, "Appraisal of the Bangladesh Krishi Bank", Manila, November 1983. Bavovada, B., "Rural Savings Mobilization in Thailand", APRACA Workshop on Rural Savings Mobilization, October 3-5, 1984, Manila, Philip-pines. Fry, Maxwell J. "Interest Rates in Asia," Study prepared for the Inter-national Monetary Fund, June 25, 1981. Lanyi, Anthony and Rusdu Saracoglu, "Interest Rate Policies in Developing Countries," Occasional Paper No. 22, International Monetary Fund, Washington, D.C., October 1983. Lee, S. Y. andY. C. Jao, Financial Structures and MonPtary PoliciPs in_ SouthPast Asia, St. M;-rti-;;:~Pre~-;, 1982.------- --~----------Meyer, Richard L., Chester B. Baker and Tongroj Onchan, "Agricultural Credit in Thailand," Research Report No. 6, Kasetsart University, Center for Applied Economics Research, Bangkok, May 1979. Meyer, Richard L. and Emmanuel F. Esguerra, "Rural Deposit Mobilization in Selected Asian Countries", APRACA Workshop on Rural Savings Mobili-zation, October 3-5, 1984, Manila, Philippines. Mridha, A.T., "Country Paper on Rural Savings Mobilization in Bangla-desh," APRACA Workshop on Rural Savings Mobilization, October 3-5, 1984, Manila, Philippines Rana, Pradumna B., "Domestic Resource Mobilization Through Financial Development: Bangladesh", Asian Development Bank, Manila, February 1984. Siswanto, "Rural Savings Mobilization in Indonesia," APRACA Workshop on Rural Savings Mobilization, October 3-5, 1984, Manila, Philippines. TBAC, "Country Paper on Rural Savings Mobilization in the Philippines," APRACA Workshop on Rural Savings Mobilization, October 3-5, 1984, Manila, Philippines. Von Pischke, J. D., "Towards an Operational Approach to Savings for Rural Developers", Savings and Development, No. 1, 1978. 

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